Human Capital Investment and Educational Policy

Transcription

1 Cha 1 Human Capital Investment and Educational Policy G Y300 E S S A Y F O U R BLOCK TWO: EUROPEAN INTEGRATION & REGIONAL DISPARITIES Eugene Clifton Cha Essay Four 10 March 2003 GY300 / Gibbons

2 Cha 2 WHAT IS MEANT BY THE TERMS PRIVATE AND SOCIAL RETURNS TO HUMAN CAPITAL INVESTMENT? WHY ARE THESE CONCEPTS RELEVANT WHEN CONSIDERING EDUCATION POLICY AS A TOOL FOR LOCAL ECONOMIC DEVELOPMENT? The idea of human capital first arose when it was discovered that outputs were growing at a faster rate than inputs deemed appropriate. If an individual was producing more with the same physical equipment, then the only explanation was an increase in the productivity of that individual an increase in human capital. The amount of physical capital was always an important consideration when calculating a firm s total productivity, but increasing attention is being given to the idea of human capital, which comprises three main components: early ability; qualifications and knowledge acquired through formal education; and skills, competencies and expertise acquired through training on the job (Blundell et al 1999). Investments in human capital which can take the forms of education and training are similar to investments in physical capital in that both potentially offer the individual or firm a greater expected return in the future. Though there exist initial costs, such as tuition fees, lost earnings, and reduced productivity, there also exist future returns, such as higher earnings and better productivity. It is important, though, to distinguish the private returns (which benefit the individual) from the social returns (which benefit the economy) to human capital investments, as this distinction carries implications for education policy as an instrument for economic development. Should there be significant social returns over and above the private returns there is then a case for providing public subsidies to align private incentives with social optimality (Harmon et al 2001). But before discussions about policy, it is helpful first to elaborate on the distinction between private returns and social returns to human capital investment. Investments in human capital occur only if the necessary costs of schooling or training are sufficiently compensated by higher future returns. These returns take two

3 Cha 3 notable forms: private returns, which accrue exclusively to the individual, and social returns, which benefit the entire society and economy. Within private returns, there are two further subcategories: returns to the individual and returns to the employer. Private returns to human capital investment. One obvious private return of human capital investment to the individual is his/her own wage. Consequently, increasing investment in human capital such as undertaking higher education leads to a greater wage. Blundell et al confirm by noting, The empirical results do suggest, in line with the theoretical literature, that education confers significant wage advantages to individuals (1999). Mathematically, if w 0 and w 1 represent an individual s wage without or with an extra year of education, respectively, then the benefit of the last year of education is: w 1 w0, where r s is the private rate of return to an additional year of education. r s With the cost of pursuing another year of education equal to lost earnings w 0, setting marginal costs equal to marginal benefits yields: w 0 w w0 =, which through rearrangement is equivalent to: 1 r s r s w w 1 0 =. w 0 Thus, the private rate of return to an additional year of education is simply the positive difference between the new wage and the old wage divided by the old wage, yielding the percentage increase in wages as a result of the last year of schooling. Using this measure, Blundell et al find that the average estimate of the gross rate of return to an additional year of education ranges between 5% and 10% (1999). Confirming findings by Harmon et al report that the returns to schooling in the year closest to 1995 across the European Union ranged from 4% in Sweden to over 12% in Ireland, with the UK at about 10% (2001; all figures for women).

4 Cha 4 Earnings are but one of the private returns of human capital investment. Other returns that accrue to the individual include: increased productivity, such that the individual is more efficient and more capable in his/her tasks employment, which also includes a positive influence on subsequent occupational status and likeliness of promotion (Blundell et al 1999) greater portability, such that skills can be transferred from one place of employment to another participation and commitment, in that trained workers are less likely to change or quit their jobs or to be made redundant (Blundell et al 1999) health leisure capacities self-esteem networking and relationships, and fertility Though noteworthy, these returns to human capital investment are problematic in that they are difficult to measure quantitatively, whereas earnings and their relationship to education and training allow for repeated statistical analysis. Still, studies by Greenhalgh and Stewart, among others, reveal strong evidence that returns depreciate, resulting in declining returns over time. Thus continued investments must be made in human capital to ensure full and lasting realisation of the private returns noted above. In addition to private returns to the individual are private returns to the employer, which are considered because employers fully or partially fund the training of workers in the hope of gaining a return on this investment in terms of being a more productive, more competitive and consequently more profitable firm in the future (Blundell et al 1999). Again, the problem here as with non-income individual returns to human capital investment is the difficulty to quantitatively measure the returns to the employer. This difficulty arises for three reasons: (1) difficulty in obtaining data on firm productivity, competitiveness, and profitability; (2) problems in distinguishing the difference between general and specific training and in identifying to whom the costs are borne; and (3) questions regarding causality. Regardless, the far-from-comprehensive

5 Cha 5 evidence that does exist show that there are notable private returns of human capital investment to the employer. Blundell et al identify that there are three areas of impact concerning human capital investment and private returns to the employer: Firm productivity. Studies showed that greater skills and knowledge in the workforces led to higher average levels of labour productivity. Firm profitability. Only few studies exist, but it is believed that investment in training remains profitable for firms since not all of the gains resulting from training are completely returned to the individual exclusively. Firm long-term competitiveness. Studies illustrate two strong correlations: first, between the employment of graduates and professionals and the usage of high-level technologies; and second, between investment in worker training and the ease of adaptation with new technologies. (Blundell et al 1999) Other returns to the employer include innovation, competitiveness, spillover effects (to be discussed in greater detail under social returns), and long-term employment. Social returns to human capital investment. High and proven rates of private returns to human capital investment remain the top impetus for individuals to pursue education and training, but benefits are not necessarily limited to the individual and the employer. Individuals usually do not take into consideration the benefits to others of their own human capital investment, even though there can be spillover effects that lead to gains that benefit the whole economy. These are the social returns to human capital investment; and, though empirical evidence is limited, such returns seem to have positive benefits on education, productivity, wages, and the general welfare within the society and local community. One social return to human capital investment is increased aggregate productivity, a form of production externality. Greenaway and Haynes (2000), as cited in Harmon et al (2001), speculate that graduates cause non-graduates to become more productive, thus raising aggregate productivity. Their work in OECD reports shows a social rate of return of about 10% in OECD countries, and even higher when students personally contribute

6 Cha 6 to the costs of their education (as is the case in the USA, Canada, and Australia) (Harmon et al 2001). Further evidence is provided by Enrico Moretti, who claims that an increase in the proportion of college graduates in a city seems to raise everyone s wages with the biggest bonus collected by those with the least education (Morin 2002). This occurs for two reasons. First, as the supply of less-educated workers declines relative to skilled graduates, their value increases and, consequently, wages rise. Second, Moretti speculates that less-well-educated workers partake in informal transfers of marketable skills with better-educated workers, leading to spillover effects that result in social returns to individual investments in human capital. Robert Topel also confirms social returns to human capital investment with a theme of economic growth. His study of South Korea, one of the four fast-growing East Asian economies collectively nicknamed the Asian tigers, revealed that an increase in the annual average of return was driven by a massive investment in public education that reduced the share of workers with a primary education from over 60% in 1970 to less than 30% by 1990 (Topel 1999). Though it was viewed that human capital was not a major cause for economic growth numerically, Topel asserts that human capital is still important and that investments in human capital, such as education, may be essential to the growth process (Topel 1999). This growth in the economy is yet another example of the social returns to human capital investment. Other obvious examples of social returns to human capital investment as identified by Blundell et al include an educated and literate population, increased political and democratic participation, and increased social cohesion. Less obvious examples include innovation, public health, citizenship, social capital, and as noted above labour productivity, other people s wages, and economic growth. However, there are difficulties in measuring the extent of these positive externalities, making it almost

7 Cha 7 impossible to calculate the exact social returns to human capital investment. Nevertheless, it is clear that social returns differ from private returns to human capital investment in that they benefit the entire society above and beyond the returns to the individual. The distinction between these two types of returns are critical in formulating education policy to foster local economic development. Policy implications. Education is a major form of human capital, and education policy thus deals with alterations to human capital investment. With convincing evidence that education reaps social returns of economic growth in addition to accruing private returns to the individual and other forms of social returns to the economy, education policy acquires an increasingly important responsibility as a catalyst for local economic development. But how strong is the relationship between a locality s education system and economic competitiveness? Bradley and Taylor in Human Capital Formation and Local Economic Performance study the interactions between the education and training system and the local economy. They provide statistical analyses which illustrate that outputs from local education and training both depend and are dependent on the locality s stock of highskill workers, which also defines competitiveness, economic performance, and thus, the local economy. In other words, there is a strong causal relationship between education and economic development. There are three channels through which a locality s education system affects its economic competitiveness (Bradley & Taylor 1996). First, research shows that the quality of schooling, curriculum, and attendance rate all affect the productivity of a locality s workers. Second, an increase in highly skilled workers occurs as in-migrants are more likely to be attracted to a locality with high attainments of educational levels. Third, new ideas and innovations from elsewhere in the economy are better utilised and more quickly received by a locality s well-educated workforce.

8 Cha 8 These channels illustrate the importance of education policy in fostering local economic development, which, in the language of earlier discussion, is a significant social return to the human capital investment of education. Clearly, economic growth is not exclusively a private return, though the individual does also benefit from the allencompassing social return of a growing economy. Regarding policy options, Harmon et al suggest that public subsidies for the costs of education are worthy of consideration if education is deemed a sufficient contributor to economic growth, but debate persists as exact measures and comprehensive evidence are still to be realised. Other policy implications include: More investment in the vocational and educational system of poorer localities so as to improve the quality of new entrants into the workforce A raising in the average skill level of economically deprived localities Cultivation of indigenous employment growth in industries with high human capital content Vigorous policies to move high-skill industries to economically deprived localities Creation of a socio-economic infrastructure that can meet the needs of professional and managerial workers, especially in economically deprived localities (Bradley and Taylor 1996) The distinction of private returns and social returns to human capital investment specifically education have led to the importance of education policy as a means of promoting a locality s economic growth. While education has a number of private returns among them earnings, individual productivity, and employment an educated individual also benefits the larger society in the form of positive externalities such as participation, labour productivity, and economic growth. It is education s contribution of economic growth that gives education policy the capacity to encourage local economic development. As noted by Bradley and Taylor, it remains important to consider education policy with its private and social returns to human capital investment within a greater context of other reforms, including urban, regional, and infrastructure policies which also contribute to the growth of a locality s economy.

9 Cha 9 BIBLIOGRAPHY Bradley, Steve and Jim Taylor. (1996) Human Capital Formation and Local Economic Performance, Regional Studies, 30, (1), Blundell, Richard, Lorraine Dearden, Costas Meghir, and Barbara Sianesi. (1999) Human Capital Investment: The Returns from Education and Training to the Individual, the Firm and the Economy, Fiscal Studies, 20, (1), El-Agraa, Ali M. (1998) The European Union: History, Institutions, Economics and Policies. London: Prentice Hall Europe. Harmon, Colm, Ian Walker, and Niels Westergaard-Nielsen. (2001) Education and Earnings in Europe: A Cross-Country Analysis of the Returns to Education. Cheltenham: Edward Elgar, Introduction. Morin, Richard. (2002) The Spillover Effect. The Washington Post, 18 August Topel, Richard. (1999) Labor Markets and Economic Growth, in Handbook of Labor Economics, ed. By O. Ashenfelter, and D. Card. Amsterdam: Elsevier,